Monday, February 14, 2011

Financial analysts could be forgiven for thinking that it was the same old story at Chelsea, as the club once again reported a thumping great annual loss of £71 million, but attempted to put the usual positive spin on the results. In an attempt to prove that he was the right man to replace former chief executive Peter Kenyon, who frequently spoke of the club’s determination to break-even, the new man at the top, Ron Gourlay, claimed, “The reduction in operating losses and increased sales in 2009/10 shows that we are moving in the right direction.”

Up to a point that may be true, but the clever wordplay does not alter the fact that the loss was actually £27 million worse than the previous year. In fairness, Chelsea’s losses had been decreasing in each of the last four years, though everything’s relative and the starting point was English football’s record deficit of £140 million in 2005. As chartists are fond of saying, “The trend is your friend – until the end, when it bends.”

Cynicism reached new highs when it was noted that Chelsea employed the politician’s preferred tactic of choosing a good day to bury bad news, not once, but twice. First, the press release announcing the results, which was amusingly entitled “Chelsea Becomes Cash Positive”, was published on the final day of the January transfer window. Then, the detailed statutory accounts were published at the same time that new signing Fernando Torres was being presented to the press.

"JT - still the main man at Chelsea?"

Moreover, it was faintly ironic that on the same day that the club revealed its £71 million loss, they also announced that they had splashed out a similar sum on acquiring the talents of Fernando Torres from Liverpool (£50 million) and David Luiz from Benfica (£21 million), thus provoking Arsenal manager Arsène Wenger, who has for a long time been a critic of Chelsea’s “financial doping”, to renew his attack on the club’s strategy, “Where’s the logic in that?”

The “Back to the Future” return to the days of big spending appeared to signal a major change of heart from the club’s billionaire owner, Roman Abramovich, whose approach to the club’s finances over the last couple of years has been positively miserly by his previous munificent standards. Chelsea have hugely benefited from the Russian’s largesse in the past, but up until last month he had clamped down on expenditure, reducing the squad size by offloading experienced (expensive) players and cutting back on support staff.

This new era of restraint was rationalised by the impending arrival of UEFA’s Financial Fair Play regulations, which should force clubs to spend only what they earn, especially as Abramovich has often been cited by UEFA President Michel Platini as one of the most enthusiastic supporters of the drive for clubs to be self-sufficient.

On the face of it, Chelsea’s January splurge would seem to fly in the face of Abramovich’s backing for the new rules, particularly as reports indicate that Chelsea also had a £35 million bid for Bayern Munich striker Mario Gomez rejected, though it is not clear whether this would have been on top of the other purchases or was an insurance policy in case the Torres deal fell through.

So, why did the loss increase, especially in a season when Chelsea secured their first League and Cup double? It’s all about the costs, as revenue is virtually unchanged, with wages being the main culprit, increasing by £20 million, though this was partially off-set by last season’s costs including £13 million severance payments to Luiz Felipe Scolari and his assistants. Last year Chelsea made £29 million profit on player sales, ironically mainly due to the transfer of Wayne Bridge and Tal Ben Haim to Manchester City (the “new Chelsea”) and Steve Sidwell to Aston Villa, while this year the sales of Andriy Shevchenko to Dynamo Kiev and Claudio Pizzaro to Werder Bremen generated a loss of £1 million. On the other hand, taking these players off the books helped reduce amortisation by £11 million.

The wage bill has now reached a stratospheric £173 million, the highest ever reported by an English club, which is £40 million more than Manchester City and Manchester United (though it is certain that City’s wages will further increase this year) and £60 million more than Arsenal. The only two clubs with a higher payroll than Chelsea are the Spanish giants, Barcelona and Real Madrid, but their revenue is also considerably higher.

The 13% increase in wages, including a mysterious £8 million rise in pension costs, does not exactly seem to support Gourlay’s previous assertion that “we are reducing our costs by controlling expenses, including salaries and wages.”

Nor does the important wages to turnover ratio, which has worsened from 70% to 82% in the last two years. This is considerably higher than all but one of their rivals for a Champions League place, the exception being Manchester City with a staggering 107%. Indeed, it’s nearly double the ratio at Manchester United and Arsenal. To get back to UEFA’s recommended maximum limit of 70%, Chelsea would have to cut the wage bill by £26 million – or grow revenue by £37 million.

That might seem a steep task, given that there have been few signs of revenue growth in the last couple of seasons. Indeed, turnover has actually fallen by £4 million since 2008, though, as we shall see later there are avenues for Chelsea to grow their revenue in the future, which will help address some of the weaknesses in their current business model.

To be fair, it’s not as if Chelsea’s revenue is too shabby at the moment. In the latest Deloittes Money League, based on 2009/10 results, Chelsea are very handily placed in sixth, which is the same as the previous season’s position. However, to place that into context, Chelsea’s annual turnover of £210 million is still a long way behind Real Madrid (£359 million), Barcelona (£326 million), Manchester United (£286 million) and Bayern Munich (£265 million), though it is within striking distance of Arsenal (£224 million).

Nevertheless, it still came as a major surprise when Abramovich found his cheque book once again. In his first three years at the club, the oligarch’s spending spree amounted to an amazing £300 million (£150 million in the first year alone, when he essentially purchased an entire new team), but the net expenditure was negligible in the following four years. The last big investment occurred back in 2006, including the likes of Ashley Cole, Salomon Kalou and the ultimate vanity purchase, Andriy Shevchenko.

This was very much in line with Kenyon’s assertion that, “We have consistently reduced our net transfer spend over the last five years and will continue this trend”, which was epitomised last summer when the only “big” names to arrive at Stamford Bridge were Yuri Zhirkov, Daniel Sturridge and Ross Turnbull (on a free transfer). Ron Gourlay repeated the need for a hair shirt policy in a team meeting at the start of the season, when he warned the players not to expect any major signings, as the club could no longer rely on handouts from Abramovich.

However, that was then, this is now and Chelsea are clearly back in the market, which can be seen by the turnaround in manager Carlo Ancelotti’s stance in the last 12 months. A year ago, he was very much still on message, “I don’t think it’s necessary for us to spend a lot of money”, but his views this year are in marked contrast, “If you do not have the players, you do not have the possibility to reach the top. Now we have that chance.”

Some commentators have speculated that the reason for Chelsea’s burst of activity is to somehow beat the UEFA Financial Fair Play rules, as the next set of accounts (2010/11) is the last year where the numbers are excluded from UEFA’s break-even calculations, but this merely betrays a lack of accounting knowledge. The reality is that when a player is purchased, his cost is capitalised on the balance sheet and is written-down (amortised) over the length of his contract. Importantly, this means that the cost of Chelsea’s recent purchases will be included under Financial Fair Play via the amortisation charge.

In this way, amortisation can have a big influence on a club’s results. For example, Manchester City’s player amortisation has grown significantly from £6 million in 2007 to £71 million in 2010. On the other hand, the slow-down in Chelsea’s transfer spend has seen their amortisation fall from £83 million to £38 million in the last five years.

Although a few journalists have suggested some accounting trickery, whereby clubs would choose to book all the huge transfer spend now as a cost, so that it would not impact future accounts, this seems extremely unlikely to me. While it is true that UEFA's regulations do allow football clubs to choose "an accounting policy to expense the costs of acquiring a player’s registration rather than capitalise them", the key point is that this must be "permitted under their national accounting practice."

"Josh McEachran - a sign of things to come"

This is highly technical, but in my view this is where their argument falls down. Ever since the introduction of IFRS (International Financial Reporting Standards), in particular FRS10 on Goodwill and Intangible Assets, major clubs have used the capitalisation and amortisation method to account for player transfers, so it would be difficult for Chelsea (or anybody else) to argue that the "income and expense" method had suddenly become appropriate.

UEFA have all but confirmed this in a recent statement, when they clarified the issue: “There is no doubt that transfers now will impact on the break-even results of the financial years ending 2012 and 2013 – the first financial years to be assessed under the break-even rule.” This was further underlined by Andrea Traverso, the Head of Club Licensing and Financial Fair Play at UEFA, who explained, “All clubs must amortise all transfer fees.”

I suppose that there is always the possibility of a club booking a massive impairment provision in 2010/11, which would dramatically reduce the value of their players in the accounts, but have the advantage of reducing future expenses. However, this has the whiff of earnings manipulation and is unlikely to be accepted by UEFA.

In fairness, UEFA have given clubs every opportunity to meet the new guidelines with a phased implementation. The first season that they will start monitoring clubs is 2013/14, but this will take into account losses made in the two preceding years, namely 2011/12 and 2012/13, so Chelsea’s accounts need to be in better shape pretty quickly.

However, they don’t need to be absolutely perfect by then, as wealthy owners will be allowed to absorb aggregate losses (so-called “acceptable deviations”) of €45 million (£39 million), initially over two years and then over a three-year monitoring period, as long as they are willing to cover the deficit by making equity contributions. The maximum permitted loss then falls to €30 million (£26 million) from 2015/16 and will be further reduced from 2018/19 (to an unspecified amount). Note that these sums represent aggregate losses, not a yearly loss, as I have seen some people erroneously report.

Even with all these allowances, the majority view seems to be that Chelsea’s recent transfer activity means that they have no chance of reaching break-even in the near future, even though UEFA themselves were at pains to point out, “The financial fair play rules do not prevent clubs from spending money on transfers, but require them to balance their books at the end of the season.”

Indeed, Chelsea remained full of confidence, “The club is in a strong position to meet the challenges of UEFA financial fair play initiatives, which will be relevant to the financial statements to be released in early 2013”, i.e. their 2011/12 accounts. Obviously, many will take that assertion with a large pinch of salt, but, for once, I think that the club’s hierarchy might be right. My analysis indicates that Chelsea might well reach break-even sooner than many would believe.

This is how I think they will do it, starting from their current pre-tax loss of £70 million.

1. Financial Fair Play Adjustments

It is not widely appreciated that UEFA’s break-even calculation is not exactly the same as a club’s statutory accounts, as it excludes certain expenses, including depreciation on tangible fixed assets and expenditure on youth development and community development activities. In Chelsea’s case, this means that £9 million of depreciation can be removed right off the bat.

It is more difficult to assess the youth development expenditure, as this is not separately disclosed in the public accounts, but we can make a reasonable estimate. In an interview with Frank Arnesen, Chelsea’s sporting director, who is due to leave the club at the end of the season, the Independent mentioned “Roman Abramovich’s £60 million plan to build Chelsea through youth development.” On the assumption that this cost refers to the amount spent by Arnesen during his five-year tenure, that would imply an annual budget of £12 million. To be conservative, I’m going to round that down to £10 million.

Fortunately for Chelsea, UEFA still allow clubs to exclude such costs, regardless of whether the programme is successful, as to date the return on investment has not exactly been dazzling. However, there are some signs that it is beginning to deliver, most obviously in the form of skilful midfielder Josh McEachran, but also, to a certain extent, with Patrick van Aanholt, Jeffrey Bruma and Gaël Kakuta. The growing pool of talent resulted in Chelsea winning the FA Youth Cup last season.

Either way, the Fair Play rules allow Chelsea to reduce their expenses by £19 million: £9 million depreciation and £10 million youth development expenditure.

"David Luiz - Sideshow Bob"

2. New Signings

The 2009/10 accounts ran up to 30 June 2010, so do not include the cost of any new signings after that date, which means that we need to add the wages and amortisation for Torres, Luiz, Ramires and Yossi Benayoun. Taking Torres as an example, his wages have been estimated at £150,000 a week, which works out to £8 million a year, while the annual amortisation is £9 million (£50 million transfer fee divided by the 5.5 years of his contract), giving a total of £17 million. Although players’ salaries are not divulged, we can make reasonably accurate estimates for the others, which give us a total of £36 million of additional costs for these four players.

3. Summer 2010 Departures

On the other hand, many high-earning players left last summer, which has taken at least £20 million off the wage bill, though this policy has also caused the club numerous problems on the pitch, as the young, emerging players are not yet ready to fill the boots of Ricardo Carvalho, Michael Ballack, Deco, Joe Cole and Juliano Belletti. A couple of lesser players (Franco Di Santo and Miroslav Stoch) also exited stage left, so my calculations suggest a reduction in wages of £23 million.

Normally, players leaving would also lower amortisation, but these players were either out of contract or only had a small amount of time left, so I have not assumed any reduction for that.

"Carvalho - first of the old guard to leave"

4. Profit on Player Sales

Although many of the players left Stamford Bridge on free transfers, Chelsea did receive money for some players: Carvalho £7 million, Stoch £4.6 million and Di Santo £1 million, giving a total of £13 million. As this year’s accounts included a loss of £1 million on player sales, that means an improvement of £14 million.

5. Reduction in Bonuses

Unless Chelsea repeat their feat from last year of winning the Premier League and FA Cup (or finally triumph in the Champions League), bonus payments should fall. These can significantly influence a football club’s expenses, as we have seen with Barcelona, who were in a financial sense victims of their own success, as they had to shell out around £33 million in bonuses. Furthermore, Chelsea have explicitly stated that they have cut performance bonuses, so there really should be a decrease here. Frankly, I have no idea how much this is worth, but for it to be meaningful enough for the club to mention it, it must be reasonably large. My estimate is £15 million (about 8% of the total remuneration), which does not seem too aggressive a target.

"Wilkins and Ancelotti - say hello, wave goodbye"

Against that, there will be a severance payment for Ray Wilkins, the former assistant manager, who left Chelsea in rather acrimonious circumstances in November. His deal was apparently worth £400,000 a year, but let’s be generous and assume a £1 million pay-off. If Abramovich tires of Ancelotti, there could be an additional “exceptional” payment here, but for the purpose of this exercise we’ll assume that “Carletto” will remain in place for the foreseeable future.

That gives a net payroll improvement of £14 million (£15 million cut in bonuses less £1 million Wilkins payment).

The latest accounts also reveal that Chelsea would be liable for an additional £3.8 million in National Insurance contributions if HM Revenue and Customs are successful in their legal case, where they argue that image rights payments should be taxed as income. As the outcome of that dispute is unclear, we shall ignore it in our workings.

6. Improved Commercial Deals

The signing of Torres will undoubtedly help the club’s commercial image, but Chelsea have already made great strides in what Gourlay described as “leveraging the brand.” In October, they signed an eight-year extension of their kit supplier deal with Adidas, which increased the annual payment by £8 million from £12 million to £20 million. In fact, some reports suggest that the new agreement could be worth as much as £25-30 million, but this is almost certainly linked to on-field success, so I have taken the lower amount.

Similarly, at the end of last season, the club agreed a new deal with shirt sponsor Samsung, which reportedly increased the annual fee by £4 million from £10 million to £14 million. That’s pretty impressive, meaning that Chelsea now have the sixth most lucrative shirt sponsorship deal globally, though it’s still a fair way behind the £20 million earned by domestic rivals Manchester United (Aon) and Liverpool (Standard Chartered). Of course, Barcelona’s £25 million deal with the Qatar Foundation has raised the bar again - even higher than Bayern Munich’s £24 million deal with Deutsche Telekom.

So, in total, there should be a hefty increase of at least £12 million from commercial deals (Adidas £8 million, Samsung £4 million). This is the figure I have used in my plan, even though other new contracts, like the one signed with Singha beer will also have grown commercial income.

Chelsea’s current total of £56 million is £25 million behind Manchester United, but this rash of new deals is closing the gap. They are keen to further exploit their commercial potential, hence they will embark on a tour of Asia next summer in order to tap into emerging markets, but they would need to hugely up their game if they want to get close to Bayern Munich’s astonishing £142 million.

This is, of course, the area where those fans that have not bothered to plough through UEFA’s regulations (and who can blame them?) see an easy way to reach the break-even target. Why doesn’t Abramovich sign a £200 million sponsorship deal? Or pay £50 million a season for a super-VIP executive box? Or buy 10 million shirts emblazoned with “Torres 9”?

"Super Frank"

Unfortunately, that simply is not possible, as UEFA have introduced the concept of “fair value” so beloved of tax authorities when reviewing inter-company transactions. In short, if an owner over-pays for services, this will be adjusted down to market value, i.e. what the club would have received if the transactions were conducted on an “arm’s length” basis. Obviously, there is still some scope for manipulation, especially as market value is notoriously difficult to assess, but the most blatant excesses should be prevented.

7. Stadium Naming Rights

Staying with the commercial arm, there has long been talk of Chelsea selling naming rights for their Stamford Bridge stadium. This is easier said than done, especially as the best marketing opportunity really lies with a move to a brand new stadium, but analysts have spoken of £10 million per annum, which is not beyond the realms of possibility. Indeed, Ben Wells, the club’s head of marketing, has waxed lyrical about looking to Asia for a sponsor, building on the club’s existing relationships in the region.

8. Ticket Prices

Chelsea raised their ticket prices at the beginning of this season. Although this is never going to be a popular move with fans, in fairness, this followed four consecutive seasons of freezing prices and was the first increase since July 2005. After inflation is taken into account, the club claimed that this represented a reduction in real terms of 15% over the period. Some accounts list the increase this year as an average 4%, while others refer to a 10% increase in season ticket prices, so I have again used a conservative assumption of 5%, which would be worth £3 million a year.

The club is limited in its ability to generate more match day revenue, because of the low 42,000 capacity of Stamford Bridge, which is considerably smaller than Old Trafford (76,000) and the Emirates (60,000). To be fair, they do get a lot of bang for their buck (yield per seat), as can be seen by the fact that their match day revenue of £67 million is much higher than Liverpool’s £43 million, even though Anfield’s capacity is actually larger at 45,000. However, they still earn over a £1 million less per match than Manchester United and Arsenal.

Their only realistic hope of matching the £100 million earned by those two clubs would be to move to a larger stadium. Although such a project did appear to have been taken off the agenda, a couple of months ago the idea of moving to a new 60,000 capacity stadium in the nearby Earls Court Exhibition Centre was again floated. Chelsea looked at the same site four years ago, so this is very far from a fait accompli, but the area is not exactly flush with alternatives. As chairman Bruce Buck said, “Certainly we wouldn’t leave West London or thereabouts, and there are very few sites available.” However, there would be many hurdles to overcome, including planning permission, and a new stadium would not be ready until 2015, so this is very much future music.

9. TV – Premier League

In line with other Premier League clubs, the main driver of revenue growth at Chelsea has been television, which is particularly evident in 2007/08, when £17 million of the £23 million increase in turnover was attributable to the new three-year deal with Sky. In the same way, the 2010/11 figures will be given an uplift by the latest three-year agreement, which kicked-off this season. Thanks to the overseas rights more than doubling, this is anticipated to deliver between £7 million and £10 million additional revenue to each club. Given that the actual amount received is partly dependent on the final league position and the number of times the team is broadcast live, I have used the lower figure in my plan.

10. TV – Champions League

In the same way, the distribution of Champions League prize money and TV payouts will also be higher this season. Again, this is dependent on a number of factors, such as how far a team progresses in the competition, how many times they win in the group stage and the share of the market (TV) pool, but an assumption of an additional £5 million is probably not too wide of the mark.

Chelsea’s revenue from UEFA for participating in the Champions League has been worth an average of £27 million in the last three seasons, and that does not include the extra gate receipts (£2.4 million a match) or higher payments from success clauses in commercial deals. All in all, failure to qualify would mean losing £40 million of revenue. No wonder the club’s accounts warn that its income is “dependent on the success of the first team.”

This is probably the main reason why Chelsea bought Torres and Luiz, as for the first time in ages there is a very real risk that they might miss out on Champions League qualification and the money that accompanies that. Simply put, the £71 million will be a price worth paying if it guarantees qualification. Of course, there’s no such guarantee in the unreliable world of football, but this statement of intent should surely help, not least in the boost it will give to the rest of the dressing room.

"Meet the new boss, same as the old boss"

So, adding up all those ups and downs brings us (spookily) to break-even. The key point here is that all of these actions have already happened with the sole exception of the naming rights, so it is little wonder that Chelsea’s officials demonstrated such confidence when announcing their latest loss. Of course, there may be other factors affecting the club’s financials, but remember that the acceptable deviations will give them plenty of room to manoeuvre.

Those of a more Machiavellian nature would no doubt maintain that all of this is unnecessary, as Chelsea could just employ an army of lawyers and accountant to locate the loopholes in UEFA’s regulations, but the figures above suggest that they do not actually need to resort to such subterfuge. In any case, UEFA are not complete fools, as they have addressed some of the more obvious ways of getting around the new regulations.

For example, many clubs these days have an intricate inter-company structure and there were fears that a club might argue that the football club itself was profitable, while large expenses such as interest payments were paid out of a different company. Clearly, that does not make sense to any reasonable man and UEFA have caught that one, “If the licence applicant is controlled by a parent or has control of any subsidiary, then consolidated financial statements must be prepared and submitted to the licensor as if the entities were a single company.”

"Bridge of Sighs"

Another possibility that some have proposed is for a club to sell a player to a “friendly” club at an inflated price, thus producing a large profit on sale. This is more difficult to police, as transfer prices on occasions appear to defy logic, e.g. a few weeks ago not many supporters would have believed that Andy Carroll would have fetched £35 million, but if this were to become a recurring theme at any club, it would be easily identifiable.

Interestingly, it does look as if UEFA are operating a “carrot and stick” approach to implementing the new regulations, as the small print in the last appendix provides a further safety net or, as Traverso described it, “a little bit of a cushion”. Even if a club misses the target, it can escape sanctions if it meets two criteria: the trend of losses is improving; and the over-spend is caused by the wages of players that were contracted before June 2010 (when the fair play rules were approved). However, that flexibility is only available for the reporting period ending in 2012, so effectively only delays the day of judgment by a year.

This begs the question of whether UEFA really would exclude clubs from European competitions. This might work fine on paper, but it might never happen in reality, especially when you consider that some of Europe’s least profitable teams are among those that attract the largest television audiences.

"Michel Platini - it's Hammer time"

Would UEFA really bite the hand that feeds? Yes, if you believe UEFA president Michel Platini, who said earlier this month, “It will have to be time for them to face the music if there is a club that doesn’t fall in line. It is not something I want, but it is something the disciplinary bodies will look at. It will be a last resort. Football will continue without them.” Asked to expand on this, UEFA's general secretary, Gianni Infantino, said, “There may be intermediate measures. We would have to ask why, maybe there would be a warning, but we would bar clubs in breach of the rules from playing in the Champions League or the Europa League. Otherwise, we lose all credibility.”

At this stage, we should probably clear up yet another misconception about the Fair Play regulations. Many seem to believe that if a club has no debt, it should be OK, but that is not the most important issue for UEFA, who are less concerned about clubs taking on debt, but more their ability to service that debt, i.e. pay the annual interest charges. Some thought that this was the reason that Abramovich converted his £726 million of loans into equity (at least in the football club, though not in the holding company, Fordstam Limited), but in reality this makes no difference to UEFA.

That said, there’s no doubt that Chelsea have gained from their owner injecting funds into the club, not just for the obvious reason that it has provided a lot of money, but also because the loans were interest-free. That’s given the Blues a considerable competitive advantage over their main rivals, who have all incurred immense annual interest charges: Manchester United £70 million, Liverpool £40 million and Arsenal £20 million.

"Abramovich - good to be back"

Chelsea’s fortunes have been inextricably linked to those of Abramovich since he started bankrolling the club in 2003. Although he was affected by the global recession, his wealth is still estimated at £7.4 billion by the Sunday Times Rich List, so lack of money is unlikely to be an issue for him. The more pertinent question for Chelsea fans is whether he still retains the same enthusiasm for the club, particularly as he has been involved in Russia’s successful campaign to host the 2018 World Cup. Last month’s venture into the transfer market might well allay supporters’ fears, though the suspicion remains that this could instead be a last throw of the dice in order to win the Champions League in the next two seasons. We shall see, though Abramovich has been true to his word so far.

As mentioned earlier, the club was keen to highlight the fact that it “had become cash positive for the first time since its acquisition by Roman Abramovich”. Chelsea’s chairman, Bruce Buck, re-iterated this point, “That the club was cash generative in the year when we recorded a historic FAPL and FA Cup double is a great encouragement and demonstrates significant progress as regards our financial results.”

Well, yes, but the only reason that the club had a (small) positive cash inflow of £3.8 million in 2009/10, compared to a net outflow of £16.9 million in the previous year, was that there was an £18 million cash inflow from transfers. In every other year of the Abramovich era, the club has had significant cash outflows and has needed to be financed by their owner, either though new loans or subscribing for additional shares.

The situation is unlikely to be any different next season after Chelsea’s large outlay on new players, so it is fair to say that the club has yet to fully wean itself off its owner’s generosity, which is reinforced by the accounts, “The company is reliant on its parent undertaking, Fordstam Limited (effectively Abramovich), for its continued financial support.”

It will be very interesting to see what happens next summer. There is now a distinct possibility that Abramovich will finance further rejuvenation of an ageing squad with exciting names like Anderlecht’s powerful young striker Romelu Lukaku, Lille’s creative midfielder Eden Hazard and Udinese winger Alexis Sanchez being mentioned in dispatches.

"Didier Drogba - on his way?"

Conversely, this may well be compensated by the club moving on a few players, not just those on the fringe of the first team like Paulo Ferreira, John Obi Mikel and Yuri Zhirkov, but also some of the big stars like Florent Malouda and even Didier Drogba. The resale value may be low, given their age, but such actions would have the benefit of slashing the wage bill and reducing amortisation.

If Chelsea do go on a summer spending spree without recouping some of their expenditure, then all bets could be off in terms of Financial Fair Play. However, up until now, it looks to me as if they have been boxing rather more cleverly than many people have assumed. As we have seen, they are indeed well on course to break-even, despite the astonishing expenditure in January, and there is evidently some method in their apparent madness.

Tuesday, February 8, 2011

Few clubs can have endured such a tumultuous start to the season as Bristol City. Following a very promising finish to last season, when the Robins won five and drew three of their last nine matches, the summer had seen the arrival of experienced manager Steve Coppell and England’s World Cup goalkeeper, David James. Although “Jamo” is clearly now in the twilight phase of his career, this still represented a notable coup for the Championship team and was a clear sign of the club’s intent.

Indeed, City highlighted Coppell’s record of taking both Crystal Palace and Reading into the Premier League, so all seemed set fair for an exciting year. However, the best laid plans of mice and men often go awry and such was the case at Ashton Gate with Coppell resigning after just one league game, citing a lack of motivation. As the man himself said with considerable understatement, the timing of his departure was not exactly ideal. Chairman Steve Lansdown agreed, “It caused uncertainty and dismay and set us back a long way in our preparations for the current campaign.”

This shambolic state of affairs was exacerbated by an unprecedented injury crisis, which meant that the club lost the services of many key players, including record signing and last season’s leading scorer, the prolific Nicky Maynard. It was therefore hardly surprising in the circumstances that City’s start to the season was so shaky with the team only winning once in its first 12 games.

"Steve Coppell - now you see him, now you don't"

Although there then followed a minor recovery of sorts, partly due to summer signings Brett Pitman and Jon Stead finding their shooting boots, the club has again struggled since Christmas. Instead of challenging for promotion, as was the original objective, Bristol City currently find themselves languishing just outside the relegation zone, which was not part of the plan at all.

Some might argue that City are setting their sights too high, given that they last played in England’s top tier more than thirty years ago, but they were perilously close to securing promotion to the Premier League in 2008, only missing out at the last hurdle when they were narrowly defeated 1-0 by Hull City in the Wembley play-off final. This was the culmination of a thrilling two seasons under the guidance of manager Gary Johnson, who lead the club to promotion from League One before finishing fourth in the Championship.

However, that was as good as it got for Johnson, who resigned just a few months later after the club plummeted to 16th position in the league, the final straw being a demoralising defeat to local rivals Plymouth Argyle. Bristol City’s form subsequently improved and the club ended the season in the mid-table respectability of 10th place under caretaker manager Keith Millen, who now has the job full-time after Coppell’s untimely exit.

Amidst all this turmoil, it might seem unreasonable for the club to even consider mounting a promotion charge, but, on the other hand, expectations among the club’s supporters should be fairly high, given that Bristol City have actually been among the highest spenders in the Championship over the last couple of years. Granted, their net spend of £3.3 million is a drop in the ocean compared to the likes of Manchester City and Chelsea, but everything is relative and this total is only exceeded by five clubs in the Championship, with Burnley leading the way after their budget was boosted by the brief sojourn in the Premier League. At the very least, Bristol City have not been a selling club, which is a fate suffered by half the clubs in the Championship.

The club’s determined chairman, Steve Lansdown, whose stated objective is “for the club to play at the highest level”, has funded this expenditure. It was this drive that initially attracted a manager of Coppell’s pedigree, “I liked what the chairman said about the club and his ambition: the plans for a new stadium and desire to win promotion to the Premier League.”

Lansdown made his fortune as one of the founders of financial services firm Hargreaves Lansdown, so much so that he was ranked at an impressive 150th position in last year’s Sunday Times Rich List, and he has been the driving force behind the club’s transformation from League One also-rans. He has frequently dipped into his own pocket to keep the club afloat, and has also made a couple of significant share sales to help fund the club’s bold plans for a new stadium.

"Keith Millen - a safe pair of hands"

When he raised £47 million in this way in April 2009, he wryly commented, “Hopefully, this shows everyone that I mean business.” Indeed, last October, he raised a further £58 million with another share disposal, though this time he merely observed that this would “free up cash for other ventures.” Lansdown still holds a 20% stake in his company, which would be worth around £500 million at the current share price of 524p, even after these share sales, so there is some real substance behind his grand scheme.

A key element of Lansdown’s aspirations for Bristol City revolves around the plans for a new 30,000 capacity stadium at Ashton Vale, close to the location of the club’s present ground. Funding for the £92 million development will come from a variety of sources, including the sale of Ashton Gate, which is likely to be converted to a supermarket, debentures, corporate boxes and stadium naming rights, though the accounts make it clear that additional funds will be provided by Lansdown “where necessary.” Despite this, Lansdown said he would not follow the example of Dave Whelan, Wigan Athletic’s chairman, who named the ground after his own business.

It was initially hoped that the Southlands housing development would contribute £5.5 million towards the project’s costs, but that was removed as part of the planning revisions agreed with the local council.

That would not be so bad, as Lansdown can easily cover the financial shortfall, but potentially much more damaging is the recommendation by an independent inspector that the entire 42-acre site should be registered as a town green, which would effectively rule out any development.

"Ashton Vale - if we build it, they will come"

This has come as a real blow to the club’s ambitions, especially as Bristol City Council had granted planning permission on the land. In fact, the council is still strongly supportive of the new stadium (and the economic benefits it would bring to the region), and has urged both sides to reach a compromise before the dispute ends up in court. As Lansdown explained, only 19 acres of the site would be needed for the new stadium, while nearly eight acres would be wetlands and the rest would be fields.

Unsurprisingly, having invested so much of his personal fortune into the project, Lansdown is not best pleased, “I bought the land in good faith, but if it loses value because town green status is granted, then it is tantamount to theft.” While it might be mildly amusing to remind the chairman of the warning on his own company’s documentation, namely, “The value of your investments may go down as well as up”, the man does have a point.

Club executives recently visited the site of Brighton and Hove Albion’s wonderful new stadium, which is a tangible example of how spirited local support can ultimately win the day in the face of small pockets of local resistance, though it also acts as a reminder that this can be a long drawn-out process, which can damage a club both on and off the pitch. Indeed, the club’s latest accounts baldy state that “the delays to our stadium project have not helped our position.”

"Another goal for Nicky Maynard"

Initially, the club had hoped that Ashton Vale might be ready in time for the start of the 2012/13 season, but that date has slipped to 2013/14 and if the town green decision goes against the club, there would inevitably be further delays (if the club opted to appeal) until possibly 2015/16.

The plans for the new stadium remain on track, even though England missed out on the opportunity to stage the 2018 World Cup. Although Bristol’s bid to be a host was based on the design for a new stadium, including the possibility to expand the capacity to 42,000 (the minimum number of seats required to host World Cup matches), this was just one of the events for which the stadium was planned. As Colin Sexstone, Bristol City’s chief executive, explained, “You don’t build a stadium for four games.” Unless you’re Qatar, as the cynics might point out.

Speaking of which, Sexstone has actually suggested that Bristol should sue FIFA on the grounds that they were misled in terms of the criteria required to win the bid, thus investing £250,000 in improving infrastructure, when that appears to have meant nothing in the final deliberations, though he may have had his tongue firmly in his cheek.

"Steady as you go"

In any case, the club believes that the new stadium is crucial to its future status. Although Ashton Gate has been Bristol City’s home for over a century, it does place constraints on its ambitions. Lansdown has described the old ground as “tired”, adding, “It would be wrong of me to say the club couldn’t survive. Of course it would. But could it survive as a good Championship side or a Premiership side? In my opinion, it wouldn’t. We need the infrastructure, we need the corporate entertainment areas.” The problem is a straightforward one, namely that the club does not generate enough revenue to consistently compete at those levels. Lansdown estimated that the new stadium would generate a third more match day revenue.

It’s not just the football club that would benefit either, as the local council spoke of the development bringing in £150 million of investment with at least a thousand more jobs. Bristol City’s chief executive, Sexstone, went further, revealing that the economic benefits of the project had been assessed at £260 million over the next 20 years.

Of course, there’s no such thing as a free lunch and the impact of the proposed new stadium has been keenly felt in Bristol City’s financials, most obviously in the club’s net debt, which has increased from £3 million to £20 million in the last two years, almost entirely due to a £15 million stadium loan, which is secured on the company’s assets. There is also £559,000 of accrued interest (Barclays base rate plus 2%), which is only payable after the loan is repaid in full.

The rest of the debt comprises: £4.1 million debt element of convertible shares (classified as debt, due to the holders’ redemption rights); an interest-free loan of £335,000 from the Football League, which is repayable in two years; and a negligible bank overdraft of £85,000.

The key point here is that the majority of the club’s debt is owed to Lansdown, as the large overdraft and loan stock that the club carried in previous year’s has effectively been repaid, which means that the club will not come under pressure from creditors, as long as Lansdown is in charge. This is also what UEFA describes as “good” debt, as it has been accumulated in order to fund revenue-generating investment into a new stadium. The other benefit is that the club’s cash flow has benefited from the much lower interest charges.

"Steve Lansdown - the man with a plan"

That said, this strategy has weakened the balance sheet, resulting in net liabilities of £10 million, compared to £4 million of net assets five years ago. As Lansdown explained, “It looks a bit of a mess at the moment, because of the push we have made to make the football club more successful.” This is a fair point, and it should also be acknowledged that the club’s assets are under-valued in the accounts.

First, the players are shown as intangible assets at a net book value of £3 million, while Transfermarkt has estimated that the sales value in the real world would be more like £19 million. Second, the current stadium at Ashton Gate is shown in the books at £9 million, retaining a valuation made in 1995, while it is reported that Sainsbury’s have made an offer of around £20 million for the land.

Even so, the auditors have still included the dreaded “Emphasis of Matter” statement in the accounts, ominously warning, “These conditions indicate the existence of a material uncertainty which may cast significant doubt about the group’s ability to continue as a going concern.” This is clearly not great news, as it means that the club is dependent on securing additional finance, but it should not necessarily be taken as a sign of impending disaster, as the same statement has appeared in the accounts for the last five years.

The reason that the club can continue to operate in this way is because Steve Lansdown has funded the club’s shortfall each year - and has pledged to continue to do so for the foreseeable future. As he put it in 2009, “There should be no doubt that we have adopted an aggressive strategy, but the board is committed to ensuring the club is not put at risk because of this.”

Just as well, as Bristol City have consistently reported losses over the last few seasons. In fact, the figures are getting worse, as the losses in the last two years have been the highest ever recorded: the £6.6 million in 2008/09 was bad enough, but last year this rose by more than £5 million to £11.8 million. Small beer by Premier League standards, but a significant deficit for a club whose turnover is only £11.1 million.

In fairness, much of this reflects the investment in the stadium development and the training ground at Failand, so the hefty loss is “not surprising” according to Lansdown, but it is also due to the money spent on new players. Indeed, Lansdown admitted, “The stadium in the past year has cost us £2 million, but it’s in football where most of the losses occurred. We pushed the boat out on expenditure at the beginning of last season and that is why these accounts look as bad as they do.” This is absolutely correct when you look at the rise in wages and player amortisation, which is the principal factor behind the worsening profits in the last two years.

"Brett Pitman - rejected Blackpool for Bristol City"

Even if we exclude the exceptional new stadium development costs and the non-cash items like amortisation and depreciation, there would still be a large loss of £6.8 million, which underscores the weaknesses in the current business model. Some clubs compensate for such a shortfall by selling players and making large profits on sale, but this is not the case at Bristol City. In the last three years, the club has only made around £1 million profit via this route with the last time any meaningful sums were produced coming in 2007 (£1.7 million, mainly from the sale of Leroy Lita to Reading) and 2008 (£2.2 million, mostly due to David Cotterill’s sale to Wigan Athletic).

It is true that the £3.7 million fees incurred in the stadium development over the last two years, which have been correctly charged to the profit and loss account, should be capitalised once the stadium is definitively approved, which would mean a cost credit in a future year. As such, the losses in the last two seasons have effectively been over-stated because of these exceptional charges.

At this point, I should note that these figures are from the accounts for the club’s holding company, Bristol City Holdings Limited, which owns 100% of both Bristol City Football Club Limited and Ashton Gate Limited, so include both football and stadium revenue.

Of the total turnover of £11.1 million in 2009/10, around three-quarters (£8.6 million) came from football with a quarter (£2.6 million) from the stadium. If we consider the stadium revenue to be commercial, then there is a remarkably even split between the three revenue streams with match day contributing 37% (£4.1 million), television 35% (£3.8 million) and commercial 28% (£3.2 million).

The television money is mainly sourced from the Football League central distribution of £2.5 million that is made to all Championship clubs, which was significantly increased last season, plus a £1 million solidarity payment from the Premier League. Although it’s great that the “best league in the world” passes some of its money down through the English football pyramid, it is also true that this represents a tiny proportion of their wealth.

Much of the stadium revenue comes from hosting major rock shows, including the likes of Bon Jovi, The Who, Rod Stewart, Elton John and Ronan Keating in recent years. OK, it’s not my taste in music, but it sure does bring in the cash. This can be easily seen by the decline in stadium revenue in 2010 from £3.9 million to £2.6 million, which Lansdown said was because they did not have a concert in the year.

"David James - the people's champion"

Football income is obviously dependent on the club’s success, which is clearly demonstrated by the revenue more than doubling in 2007/08 from £4.3 million to £8.8 million following City’s promotion from League One to the Championship. The cup competitions are now treated with thinly veiled contempt by Premier League clubs, largely due to the feeble prize money, though these can still make a useful contribution to other clubs, e.g. if a Championship club reaches the sixth round of the FA Cup, it receives £338,000 compared to just £27,000 if it is eliminated in the third round, not to mention additional fees of £144,000 if a match is televised live.

However, this all pales into insignificance if the club can somehow achieve promotion to the promised land of the Premier League. As Lansdown explained, “I think most clubs in the Championship run with big losses. The dream we’re all after and what we’re spending the money to try and achieve is the television money and the commercial rights that go with being a Premier League club.”

And he’s not wrong if you compare the huge disparity between Bristol City’s £11 million revenue and the £54 million earned by Bolton Wanderers in the Premier League. The gate receipts at the two clubs are more or less the same (Bristol City £4 million, Bolton £5 million), but there is an enormous difference in TV revenue: Bristol City have £4 million, while Bolton receive around ten times as much at £38 million. Given the size of the prize, the “balls out” strategy employed by many clubs to secure promotion makes a little more sense, though clearly only a few can be elevated each season.

Hang on a minute, I hear you saying, that’s a lot of money, but didn’t I read somewhere that the Championship play-off was worth £90 million? Well, yes it is, but not all in one fell swoop. Following yet another increase in the Premier League television deal, the club that finishes bottom this season will earn around £40 million, but it will also be in line for £48 million in parachute payments over four years (£16 million in each of the first two years, and £8 million in each of years three and four). On top of that, you would expect gate receipts and commercial income to be higher, hence at least £90 million more revenue.

The parachute payments are designed to help soften the financial blow of relegation, on the assumption that the clubs cannot immediately reduce their operating expenses, which is very considerate of the Premier League, though some would argue that they actually distort competition in the Championship, as they give relegated teams an unfair advantage. It smacks a little of “once you’re in our club, we will do everything we can to keep you in (and the others out).”

"Jamie McAllister - flower of Scotland"

Given City’s proximity to the relegation places, it’s also worth taking a quick look at the TV money earned by League One clubs. I’ve taken Brighton and Hove Albion as an example, purely because they are the current league leaders (and it maintains the alliteration). Although not on the same scale as the gap to the Premier League, relegation would still make a nasty dent in the club’s financials with television money falling almost £2 million to £656,000.

Bristol City’s match day revenue also suffered last season, falling from £5.1 million to £4.1 million, as average attendances dropped by 13% from 16,816 to 14,600. This was partly down to lack of success on the field, aggravated by early exits in both cup competitions, and partly due to the poor economic climate. The club has launched a number of initiatives to counter this trend, including half-season tickets covering the final 12 Championship matches, where adults can watch a game for just £19, and many “pay on the day” schemes to encourage support.

Given that the average attendances are much lower than Ashton Gate’s capacity of 21,500 (though it can be reduced to 19,000, depending on how away fans are segregated), it raises the legitimate question of whether the club’s desire to move to a new stadium makes sense. There is a risk that Ashton Vale could be a white elephant, though, in fairness to Bristol City, their plans do not depend on taking on vast amounts of debt, assuming that Lansdown continues to provide the financing.

"Gary Johnson - where did the magic go?"

Clearly, Bristol City’s match day revenue is never going to reach the heights of clubs like Manchester United and Arsenal, who both earn more than £100 million a season, but increasing this income stream to the levels of the likes of Bolton, Birmingham, WBA and Blackburn is a realistic target, which presumably means that the Premier League vision is not completely ridiculous.

Furthermore, even if the club were to remain in the Championship, this does not necessarily mean low crowds. In fact, more people watched Championship matches last season (9.9 million) than attended Serie A games in Italy.

As Lansdown has indicated, there is also scope for growth in commercial revenue. The shirt sponsorship is provided by DAS, a legal expenses insurance company, who replaced the Bristol Trade Centre in 2008. Both fine businesses, no doubt, but you would expect the club to secure more lucrative deals if they reached the top tier. Similarly, the club has fairly recently signed a new kit supplier deal with Adidas, replacing Puma, but such agreements normally also include success clauses, based on promotion.

On the cost side, like all football clubs, the wage bill is by far the largest element, but it’s a real humdinger at Bristol City, having risen inexorably to £13.8 million, which is an incredible 124% of turnover. To place that into context, it’s even more (worse) than big-spending Manchester City’s ratio of 107%, though, in fairness, this ratio tends to be higher in the Championship, largely down to the far lower revenue.

The club is painfully aware of the “challenging financial position” that is caused by “higher wage bills”, but Lansdown pointed out that “the increase in wages is to a certain extent inevitable, if we are to compete in the Championship and have aspirations of getting into the Premier League.”

Despite the steep 35% rise in wages from £10.2 million in 2009 to £13.8 million, Lansdown has admitted that the club did not really get value for money last season. They took on a lot of loan players (Saborio, Sno, Agyemang, Iwelumo, Maierhofer and Velicka), who contributed little to the cause, while they also had to give former manager Gary Johnson a pay-off.

Even after all this expenditure, City’s wage bill is by no means the largest in the Championship, though it may well further increase this season, due to the change in management at the beginning of the season. Steve Coppell’s departure has clearly cost the club money, as some of the players he recruited during the summer were not rated so highly by Keith Millen, who has introduced his own selections.

"Marvellous Marvin Elliott"

Indeed, Millen has been informed by Lansdown that he will need to reduce the squad, which he has described as “too big and imbalanced.” It was as high as 35 before the January transfer window, which is way above the chairman’s target of 24. However, for this to have any meaningful effect on the wage bill, this would mean selling (or releasing) the higher earners, like David James, Nicky Hunt, Kalifa Cissé and Damion Stewart, which might damage the team’s promotion prospects.

The extent of the club’s financial challenge is illustrated if we analyse what it would have to do to get back in line with UEFA’s recommended maximum limit of 70% for the wages to turnover ratio. Either they would have to cut wages by £6 million (44%) or increase revenue by £8.6 million (77%). Neither choice appears very credible in the short-term, though the revenue target would be easily achieved, if the club did reach the Premier League.

How prescient Lansdown was in 2008, when he cautioned, “It is going to be increasingly difficult to keep wages under control if we wish to progress as a football club.” Then again, this did represent something of an about turn from the chairman, when you consider his words back in 2006, “The current wage structure in football is simply unsustainable. Clubs will be reducing their wage bills, because they have to if they want to survive.” To be fair to Lansdown, these two diametrically opposed points of view perfectly sum up the dilemma facing most football clubs.

The trend in player amortisation, namely the annual cost of writing down the cost of buying new players, also reflects the changing approach, as this has increased from £0.2 million in 2007 (the last season in League One) to £2.2 million. Indeed, if we look at Bristol City’s transfer activity over the last eight seasons, it is clear that this is no longer a selling club. In the four years up to 2007, the club had net proceeds of £4 million, while in the last four years the pendulum has swung and City have incurred net spend of £9.6 million. Again, this is hardly crazy money, but it does show a marked change in intent since the promotion to the Championship.

This strategy is explicitly outlined in the accounts, where the club affirms that the principal factor affecting profitability is the success of the team, which is why it commits “substantial sums of money for the acquisition and development of new players.” That said, manager Keith Millen demonstrated an admirable commercial outlook, when he accepted City’s need to sell before they can buy, even going further, “We need to be bringing in players who have a long-term future at the club and whose valuation is going to go up. You need to have saleable assets.”

However, this is not so straightforward these days, as transfer revenue for lower league sides has virtually dried up. Records may have been smashed in the upper echelons of the Premier League this month, but precious little money found its way outside the select few. This means that clubs in the Championship have needed to make judicious use of the loan system and Bristol City are no exceptions. They took Danny Rose (he of the once in a lifetime goal against Arsenal) and Steven Caulker from Tottenham Hotspur on season-long loans, while Irish international striker Andy Keogh has recently joined them on a three-month loan from Wolves.

Exorbitant transfer fees and wage demands mean that the club’s academy is another important element of its strategy. The development of home grown youth players for the first team, like Christian Ribeiro and Cole Skuse, is a possible route to financial salvation. Indeed, the club has described it as essential, which explains the continued investment into the academy training facilities.

In the meantime, the club will have to rely on the support of the board to see it through what it describes as “difficult times.” There are huge cash outflows (£22 million) in the last two years alone before financing eliminates the deficit. This effectively means Lansdown, who, as we have seen, has provided a £15 million stadium loan and also provided capital by purchasing £13 million of new shares. There is little sign of this financial support coming to an end with the latest accounts stating, “Since the year end Stephen Lansdown has agreed to subscribe for additional shares and/or loan stock in the coming year should the need arise.” In short, Bristol City literally owe Lansdown a great deal.

This business model works fine as long as Lansdown is around to pick up the tab, but there must be concerns about what would happen if he were to exit stage left. His involvement is already partially restricted, as he lives in Guernsey as a tax exile, so can only be in the UK for 90 days in a year. Although the man himself has reassured supporters with a promise that he “won’t leave this football club in the lurch”, he has also warned that he may consider walking away, if plans for new stadium at Ashton Vale are thwarted.

There’s a palpable sense of disappointment in his voice, when he considers other options if that eventuality came to pass: “Plan B will have to be to retrench to Ashton Gate and see what we can do there. We will have to cut our cloth accordingly and we won't be having the same dreams and ambitions as we do at the moment.” He continued to say that if the new stadium did not progress, he would essentially get things set up properly and then look to hand over the club to someone else, maybe an overseas investor, to finish the job.

"Christian Ribeiro - the future boy"

Hopefully, that is not the case and the club will eventually be able to move into a new stadium, where they would have a fighting chance of becoming self-sufficient. At its simplest, the club “needs to increase its turnover and control its costs”, which is an obvious point, but one that was emphasised in the chairman’s statement in the last accounts. In the absence of a new stadium, that looks very hard to do, at least without compromising the club’s ability to challenge for promotion to the Premier League, so for the foreseeable future large losses are likely to be the order of the day.

It is clear that Bristol City are following a “speculate to accumulate” strategy, or, as they put it, “setting down foundations to establish a top-class football club and stadium facilities.” With appropriate fanfare, Lansdown told a supporters’ meeting that with a new stadium the “sky is the limit”, painting a picture of Bristol becoming an international city “to rival the likes of Barcelona and New York.”

OK, that might be a bit over the top, but there’s little doubt that a city of Bristol’s size (England’s sixth largest) could one day support a Premier League team. For the moment, the club would probably do better to look over their shoulder rather than too far ahead, as the first priority must be to survive in the Championship this season. In the future, if and when Ashton Vale is built, then who knows?

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